Structural Models and Endogeneity in Corporate Finance: The Link Between Managerial Ownership and Corporate Performance

Abstract

Abstract:This paper presents a parsimonious, structural model that isolates primary economic determinants of the level and dispersion of managerial ownership, firm scale, and performance and the empirical associations among them. In particular, variation across firms and through time of estimated productivity parameters for physical assets and managerial input and corresponding variation in optimal compensation contract and firm size combine to deliver the well-known hump-shaped relation between Tobin's Q and managerial ownership. To assess the effectiveness of standard econometric approaches to the endogeneity problem, we apply those remedies to panel data generated from the model. The unfortunate conclusion is that, at least in the ownership-performance context, proxy variables, fixed effects, and instrumental variables do not generally provide reliable solutions to simultaneity bias. 2 ABSTRACT This paper presents a parsimonious, structural model that isolates primary economic determinants of the level and dispersion of managerial ownership, firm scale, and performance and the empirical associations among them. In particular, variation across firms and through time of estimated productivity parameters for physical assets and managerial input and corresponding variation in optimal compensation contract and firm size combine to deliver the well-known hump-shaped relation between Tobin's Q and managerial ownership. To assess the effectiveness of standard econometric approaches to the endogeneity problem, we apply those remedies to panel data generated from the model. The unfortunate conclusion is that, at least in the ownership-performance context, proxy variables, fixed effects, and instrumental variables do not generally provide reliable solutions to simultaneity bias.

Founders versus non-founders in large companies: financial incentives and the call for regulation

“…Morck et al (1988b), McConnell and Servaes (1990), Smith and Watts (1992), among others, find firm size to be related to firm value. Importantly, Coles et al (2003) show that the results are different when one controls for size using the natural logarithm of sales or the natural logarithm of assets. Accordingly, we make sure our results hold for both these size proxies.…”

“…By using all four measures for the CEO's pay-performance sensitivity, we ensure that our results are not dependent on any one definition. Coles et al (2003) show that one obtains different results when one controls for size using the natural logarithm of assets (Lasset) or the natural logarithm of sales. Accordingly, we make sure that our results are robust to using both these size proxies.…”

Substitutability and complementarity of corporate governance mechanisms in Latin America

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“…Mills ratio -Since board independence can jointly influence backdating decision and share price response, our empirical analysis may be subject to selection bias [see Bhagat and Jefferies (1991) and Coles et al (2007) for a discussion of this issue]. To control for such selection bias, we include the Mills ratio from the logit model used earlier.…”